The Long View
Steve Grice, Director
The traditional mainstream banks have been providing finance to SME’s for many years, but structural changes in the market, already being felt, mean that in the long term, banks will not play a central role in the funding of SMEs in the future.
Over the last few years the lower echelons of banks’ business finance operations have been centralised and automated.
Decision making at this level (let’s say for assessing businesses under £5M turnover) is largely score-driven and managed remotely. This is a trend that began well before the financial crisis and is being driven by two inter-related forces: The need to deliver services at a lower cost; and the need to de-risk bank lending portfolios due to increased capital regulation.
The result of this trend is the exponential growth of the alternative finance market, led by the main Peer-to-Peer platforms. At this end of the market, they are able to service a greater number of small businesses more quickly and provide more tailored responses than the mainstream banks.
While P2P lending overall may at the moment be a drop in the ocean next to the sum total of mainstream bank business lending, I’d argue at the smaller end the banks are going through a process of managed retreat, whether they realise it or not.
For facilities such as loans or overdrafts that require banks to hold capital reserves, alternative finance providers are on a long-run gain, because they can deliver at a much lower cost and they are not required to hold regulatory capital. Banks simply cannot compete with the much lower cost base of P2P providers.
Of course, banks will still have a role in running business bank accounts, and providing transactional services, and the changes aren’t a bad thing for the banks – they may protest in the short term, but they will allow the competition to eventually take away that portion of their business that they cannot service profitably.
From the point of view of bank CEO’s the long-run structural changes in the business finance market will have the effect of making banks more profitable. And they will seek to ‘graduate’ the best SMEs to bank funding as they grow.
The overall effect is that over the next couple of decades, business finance will come to look much different from the traditional model, at least for smaller businesses.